Key Points:
- The US economy remains strong, delaying the need for rate cuts further into 2024.
- Stocks had a strong month in February with the S&P500 gaining 5.3%.
- Investors enjoying high current money market yields may want to consider stocks and bonds which tend to offer better inflation-adjusted returns.
The US economic slowdown that never materialized in 2023 seems to be keeping inflation above the Federal Reserve’s target. The robust economy is surviving on higher interest rates and disappointing investors hoping for a rate cut. However expectations for a softening labor market may slow consumer spending this year. The idea of a “soft landing” for the US economy is becoming more probable. Risk assets moved higher in February with most of the major stock indices advancing. The S&P500 gained 5.3% with consumer discretionary (8.7%), industrials (7.2%) and materials (6.5%) leading the way. While all sectors were positive, utilities (1.1%) lagged the overall market. Small caps (5.7%) bounced back from a difficult start to the year, while value stocks continued to lag growth.
International stocks also moved higher during the month with both developed and emerging markets advancing on news that China will provide stimulus to bolster its slowing economy. The slowdown in China has dampened demand for commodities, which should help global inflation decline. Economic recessions in Germany and Japan were likely caused by weak demand in China, a major importer of their industrial goods.
Interest rates moved higher in February as bond traders continued to adjust to higher-for-longer interest rates. The Federal Reserve is expected to leave the Fed Funds rate unchanged in March, with cuts to policy rates not expected until May or June. The Bloomberg US Aggregate Bond Index dropped 1.41% during February as rates ticked up. Investors expecting lower rates toward the end of this year have poured over $7B in intermediate term bond funds this year according to Morningstar. As interest rates move down, the price of existing bonds moves higher as they offer higher relative yields.
As stock indexes push all-time highs this year, many investors are still on the sidelines in money market funds which currently offer attractive yields. These high yields will slowly go away as the Fed normalizes policy rates. Over time, money markets tend to not offer attractive “real yields”, which takes inflation into account. Cash investors with long time horizons and low liquidity needs should consider the current attractiveness of bonds and adding to equities during market pullbacks.
Sources: Morningstar Direct, Wall Street Journal, BEA.gov